Infosys saga & the issue of corporate governance

IT major Infosys has been in the news after the company's founders expressed concerns over transparency and corporate governance. They have questioned the compensation package of Chief Executive Officer (CEO) Vishal Sikka and the severance package to its former chief compliance officer David Kennedy.

Infosys founder N R Narayana Murthy has asked how the company would achieve the $20-billion target by 2020, as set by Sikka, in an uncertain global environment, said sources.

Last month, Murthy and other founders Nandan Nilekani and Kris Gopalakrishnan raised their concerns with the board.

Last year, promoters of Infosys had abstained from voting to give an extension to Sikka for another two years. The extension also came with an increase in compensation. This renews concerns about issues with corporate governance within the realm of Indian industry.

Corporate governance is the system by which business corporations are directed and controlled. The corporate governance structure specifies the distribution of rights and responsibilities among different participants in the corporation, such as the board, managers, shareholders and other stakeholders, and spells out the rules and procedures for making decisions on corporate affairs.

By doing this, it also provides the structure through which the company objectives are set, and the means of attaining those objectives and monitoring performance.

However, corporate governance has wider implications and is critical to economic and social well-being, firstly in providing the incentives and performance measures to achieve business success, and secondly in providing the accountability and transparency to ensure the equitable distribution of the resulting wealth.
Significance of corporate governance

The significance of corporate governance for the stability and equity of society is captured in the broader definition of the concept offered by Sir Adrian Cadbury (2002): "Corporate governance is concerned with holding the balance between economic and social goals and between individual and communal goals.

The governance framework is there to encourage the efficient use of resources and equally to require accountability for the stewardship of those resources. The aim is to align as nearly as possible the interests of individuals, corporations and society."

Effective corporate governance ensures the optimal use of resources both intra-firm and inter-firm. With effective systems of corporate governance, debt and equity capital will go to those corporations capable of investing it in the most efficient manner for the production both of highly demanded goods and services as well as those with the highest rate of return. This

helps to protect and nurture scarce resources thereby ensuring that societal needs are met. In all probability, this will mean that incompetent managers are replaced.

These efficiency effects both as to scarce resources and the quality of managers should apply whether a firm is a state-owned enterprise, a private closely held firm owned by a family group, or a publicly traded corporation on a stock exchange.

Effective corporate governance also helps to lower the cost of capital by improving the confidence of both foreign and domestic investors that their assets will be used for the purposes agreed.

A survey of institutional investors found that they would willingly pay on average well over ten percentage points more for a ‘well-governed’ company, all other things being equal.

In competitive markets, this means that managers must constantly evolve new strategies to meet the changing circumstances. This requires that managers be empowered to make decisions.

When corporate governance is effective, it provides managers with oversight and holds boards and managers accountable in their management of corporate assets.

This oversight and accountability combined with the efficient use of resources, improved access to lower-cost capital and increased responsiveness to societal needs and expectations should lead to improved corporate performance.

Effective corporate governance should make it more likely that managers focus on improving firm performance and are replaced when they fail to do so.

In addition to this, the developed countries also have well-developed private sector institutions such as organizations of institutional investors, professional associations of directors, corporate secretaries and managers, as well as rating agencies, securities analysts and a sophisticated financial press.

On the other hand, many emerging countries have not yet developed fully their legal and regulatory systems, enforcement capacities and private sector institutions required for effective corporate governance.

There is in many of these countries, a need for further development of the stock exchange, systems for registering share ownership, enactment of laws for the protection of minority shareholder interests, the empowerment of a vigilant financial press, the improvement of audit and accounting standards and a paradigm shift in the mindset against the widespread tolerance of bribery and corruption as an unavoidable cost of doing business in some of these countries.

In view of these observations, the Board of Directors at Infosys needs to take into account stakeholder concerns in order to ensure effective corporate governance.

The former founders may have relinquished control but are still entitled to comment when they are legitimately concerned about the well-being of the company’s shareholders.

The Board of Directors must keep in mind that their duty lies, first and foremost, to the shareholders of the company. If questions are being raised about the governance standards they must be addressed in an open and transparent manner.

That is the only way to bolster investor confidence in the well-being of the company.

(The author is the founder of Hammurabi & Solomon and a visiting fellow at the Observer Research Foundation.

The article is an abridged version of his write-up in
Firstpost.com)